Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 11 - Evidence
OTTAWA, Thursday, February 6, 2003
The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:05 a.m. to examine and report upon the present state of the domestic and international financial system (Canadian perspective to the Enron collapse).
Senator E. Leo Kolber (Chairman) in the Chair.
[English]
The Chairman: Honourable senators, we are continuing our study of the Canadian perspective to the Enron collapse. Our first witness, from the Certified General Accountants' Association of Canada of Canada, is Mr. Guy Legault. If you have an opening statement, please proceed.
[Translation]
Mr. Guy Legault, President, Certified General Accountants Association of Canada: It is indeed a pleasure to be here again before this committee. I have been following the testimony that you have received from a wide variety of witnesses over the course of your current reference and I want to congratulate you on the depth and breadth that has characterized this inquiry.
[English]
When we first appeared here last May, we addressed the issues of accounting standards and corporate governance. Today, I will concentrate on the standards issue and provide some new ideas for your consideration.
At the time of our last appearance, CGAA Canada had just commissioned the Centre for Collaborative Government to explore some key issues around standard setting in Canada and to produce a discussion paper that would help the broader policy community understand what events such as the Enron and WorldCom debacles meant for the future of accounting standards in Canada. We did this because we adhere to the notion that, in this increasingly globalized economy in which capital moves virtually freely across national boundaries, it is essential that all stakeholders, including governments, corporations and investors, have access to reliable and comparable financial information that is of the highest quality.
Equally important, we believe that the manner in which that information is generated be subject to the highest possible standards of transparency, accountability and democracy, and that meeting these tests is not simply a matter for internal consideration by the accounting profession but rather is a subject for open, public debate.
As I wrote in the forward to the centre's final report, accounting standards for the 21st century are no longer simply a matter of arcane rules for accountants and the preparation of financial information for their clients. Rather, financial reporting standards have become a matter of significant interest to national governments around the globe. Policy- makers and stakeholders in Canada have a responsibility to re-examine the process by which those standards are set as part of an overall assessment of contemporary corporate governance practices.
The paper that was prepared by the centre under the leadership of its director, Dr. Don Lenihan, is the product of a consultation process which might be described as a virtual round table in which a group of distinguished Canadians came to grips with the matters at hand through a series of conference calls and one-on-one interviews.
[Translation]
The report that I am referring to is being made available to you and I commend you to its contents.
In reading it, you will note that there was vigorous debate about all of the relevant issues and on some there emerged no consensus. I am, however, pleased to report that on the question of whether or not there should be a universal set of accounting standards applicable in all jurisdictions, there was little or no disagreement.
Many participants agreed that the debate over rules-based versus principles-based accounting systems is grossly over-simplified and that every system combines rules and principles.
With very few exceptions, the group thought that, over the long term, the work of the International Accounting Standards Board, or IASB, and the United States' FASB would likely tend to converge. The result might be a kind of third option which is really the best of the best.
In that regard, I draw to your attention the October 2002 announcement of the Norwalk Agreement in which the FASB and the IASB agreed to work together toward convergence of global accounting standards.
[English]
The second part of the centre's report contemplates the future and asks what, in the ideal, should standard setting look like in Canada in the 21st century. What emerges here is a set of basic principles upon which the study group felt such a system must be built. Words such as expertise, accuracy, transparency, simplicity, fairness, impartiality, balance and independence appear frequently in this section of the report.
While I think it would be accurate to say that all participants subscribed to the sentiments that are reflected in these words, it would not be fair to say that there was consensus as to whether or not the current standard-setting system in Canada meets the test.
Before I go on to make my case for reform of the status quo, I want to make it crystal clear that I do not question the commitment of the Canadian standard setter to excellence, nor do I question the integrity of the people who are involved in the endeavour. I do, however, question the wisdom of its sponsors who continue to insist that the system is above reproach. Here I must be blunt: It is not.
The Canadian Institute of Chartered Accountants funds and operates the Accounting Standards Board, which is accountable to the Accounting Standards Oversight Council, which, in turn, is accountable to the board of directors of the Institute of Chartered Accountants. This appearance of possible conflict of interest is unacceptable.
In the wake of Enron, the responsible authorities in Canada concluded similarly and moved to create yet another layer of oversight last year. I am referring, of course, to the creation of the Canadian Public Accountability Board or CPAB. While it is a step in the right direction, it is also flawed in its non-inclusive structure.
In a recent study comparing the accounting standards structures in Canada, the United States, the United Kingdom, Germany, Japan, New Zealand and Australia, the author found that Canada is the only country that has a standard setter fully within the control of a professional accounting body. It is the only country in this group with a standard setter that does not have a base of funding outside of professional accountancy bodies.
One is compelled to ask whether all of these countries have it wrong and only Canada has it right. I think not.
Mind you, independence alone is no guarantor of perfection as we have seen in the United States over the past couple of years. However, the U.S. government moved swiftly with the passage of the Sarbanes-Oxley Act to tighten rules that now require CEOs and CFOs to personally warrant the veracity of financial statements of public companies.
If it is regarded as improper for auditors to leverage their auditing assignments into lucrative consulting arrangements with clients, why would the same principle not apply in the instance of how accountants in Canada structure the standard-setting process?
We regard the status quo in this matter as an intolerable state of affairs which, I am quite sure, will not be remedied without the intervention of Parliament. There is simply no evidence that the monopolist will voluntarily divest itself of its privilege.
Therefore, we call upon honourable senators to recommend that the necessary legislative reforms be passed and regulatory changes be promulgated to ensure that the principles of transparency and independence in accounting standard setting in Canada are respected and enforced. A simple amendment to the Canada Business Corporations Act and a change in our regulation pursuant to that legislation is all that is required to institute the necessary reforms.
[Translation]
As to the governance model that might be utilized, there are sufficient numbers of existing models in Canada and in the world. Whether the model may be government appointed which is used in Australia, the private sector model as reflected by the arrangement in place in the United States or a third hybrid model that would include government and the private sector as partners. Surely it is possible for parliament, in consultation with stakeholders, to design an appropriate system.
It is not in the public interest that the status quo prevails. I am now happy to answer your questions.
[English]
Senator Angus: The thrust of your argument is that Canada has it wrong in terms of accounting standard setting. We are in an environment where all of the westernized nations are taking a hard look at accountability in the wake of the Enron and related scandals; yet, in Canada, we have a profession that is basically policing itself. The Canadian Institute of Chartered Accountants, still, is given the overall responsibility of setting in place a process for setting standards.
Having said that the appearance of conflict of interest is unacceptable, I believe it would enhance your own credibility if you could remind us where your organization stands. I know there has been a difference of opinion between your organization and the CICA. I think it has to do with the fact that your folks do not do audits.
Is there a conflict here? I am hoping you will be able to say there is not — and explain why that is the case — in order than your argument might be viewed in a positive way.
Mr. Legault: Let's call a spade a spade. You are talking about a turf war. It is not about a turf war. Our organization and our members have the right to audit companies, including public companies, in eight jurisdictions now, with Ontario. We are waiting for the regulations. Honourable senators are probably aware that new legislation has been passed. It is a matter of time before all of the jurisdictions fall into place.
I want to look at the issue and to make the case that Canadian society adopts the values of diversity and tolerance, that we value competition because that fosters innovation, and that we welcome debate. We are asking you to view the situation in such a way that Canada can benchmark itself with the best practices around the world. We are asking you to look at our institution and ask whether we have the best system.
We have looked at seven countries. In some countries there was only one designation, whereas others had multiple designations. We found they all do it differently by making sure that it is independent from the accounting profession. Accounting standards are too important to the economy to be decided only by the accountants. Accountants do have the expertise, but the governance of the institution must be independent.
The international accounting standards committee that was in place prior to the Accounting Standards Board once belonged to the accounting profession. At the 2000 annual meeting of the International Federation of Accountants, the 150-member body, including the Canadian organizations, unanimously decided to sever ties with the International Accounting Standards Committee in order that it would become an independent board that would fall under the responsibility of independent trustees and raise its own funds. That was a unanimous decision. If it is good enough for the international body and the major countries, why is it not good enough for Canada?
A question I would ask is this: Would you make one of the big three car manufacturers responsible for setting safety standards for the entire automotive industry? That is the situation we have here. I believe that any objective party should be able to conclude that what we are facing is a public policy issue.
Senator Angus: I agree with you. Many witnesses on this set of hearings have pointed us to issues similar to those you have spoken to this morning. There is a lack of uniformity in Canada. That is one of the problems that goes directly to the issue of investor confidence: With respect to the U.S. GAAP and the Canadian GAAP, as well as the standards of the IASB and companies that are doing their own quarterly reports, depending on what standards are applied, you can get a vastly different result. Therefore, investors have lost confidence in the numbers. That is one of the reasons this issue is now before us.
We asked witnesses from the CICA about the issue of conflict of interest as it relates to the Canadian system and they told us that they, in their oversight board, are going out of their way to ensure there is no conflict of interest. The chairman and members of the board are not chartered accountants. It is now dominated by non-CAs. Would you comment on that? I would not want this committee to think that it is now independent if your evidence is that it is not.
Mr. Legault: As I said in my opening remarks, we do not question the integrity of the people who have been asked to serve on this pseudo-independent oversight council that is supposed to be independent. We are saying, as honourable senators are aware, not only is conflict of interest an issue but also the appearance of conflict is an issue. We see that there are two co-situations where there is a layering but, ultimately, it all comes back to the board of directors of CICA that makes the decisions about funding and staffing. One must look at that and conclude that there is obviously undue influence or a possibility of undue influence where they are paying the bills, staffing and housing the organization, and they basically have control.
Despite the fact that you put a structure in place with some form of independence, there is still this appearance of conflict that is real, and that basically does not meet the test.
Senator Angus: Mr. Legault, you have clearly articulated the malaise. I believe you have said that the solution is a simple one. All it requires is an amendment to the CBCA and some new consequential regulations under that act.
It would be helpful, Mr. Chairman, if we had the text of the suggested amendment that you would have in mind. Do you have something already drafted or could you send us something?
Mr. Legault: We have not gone that far yet. The reason we have not gone that far is due to the fact that we need a public policy statement on the issue. If you are already there, I will be more than happy to get the draft to you quickly. We believe that there are some options. In the report from the Centre for Collaborative Government, some of those options are laid out.
We do have some precedents in Canada in for form of organizations like the CRTC or NAV CANADA which are more like independent organization. Government has two choices: Either it creates a statutory organization through an act, or it creates another non-profit organization with a certain set-up and then lets it go. In the future, it will be self- perpetuating and it will work that way.
The authority is now delegated to the institute by reference to the handbook through regulations. Therefore, it could be done through either a change in regulation that refers to the handbook of another organization if it is a private, non-profit organization, and if it is a statutory organization it may require legislation.
Senator Angus: I will stop at this point. The reality is that a public policy debate on this subject is taking place as we speak. Clearly, there is an issue, or the debate would not be taking place.
You are advocating a substantial change in the way standards are set in this country, and you have stated that a simple amendment would fix the problem. If you could give us that — send a letter to the chairman to be part of the record of this hearing — it would be very helpful.
Mr. Legault: I will do that.
Senator Fitzpatrick: You have indicated, and I agree, that we should have the best practice here in Canada. It will be a question of what that best practice will be. I will ask that question in a moment. However, you have stated that there is a different structure in the United States, the U.K., Germany, Japan and some other countries.
I realize that this would be subjective to a certain extent, but do you have any information, other than anecdotal information, that would support the position that these other structures work better than the structure we have as it relates to misinformation, failures, or whatever the case may be? Is it just a question of appearing to do the right thing? It would be helpful to us if we had some statistics to support the contention. You may have that information now, or you may wish to submit it to us later.
Mr. Legault: We have already provided the clerk with a report on accounting standards setting structures to which I have referred in my remarks. It compares the system in various countries and looks at funding issues.
There is a note in that report that does address the point that you raise, senator, that we have not been able to go as far as looking at the performance of those standard setters through their capital markets. That is obviously a much more difficult task.
As I mentioned in my remarks, we have not and we are not questioning the results of our system. Some of our standards are the best in the world. However, our structure and institutions do not meet the test of independence when it comes to worldwide practices. That is what I think we must fix.
Having said that, I reiterate what I said earlier: We are not saying that we have bad results, but we are saying we have a lack of accountability. I believe parliamentarians should be concerned about this lack of accountability. If things were to go bad, where would you turn? Where would we turn? It is better to fix things now that we have a focus on those issues and ensure we have full accountability in the future.
Senator Fitzpatrick: Are you saying that your organization should bear some of the responsibility for this as well?
Mr. Legault: We need to realize that accounting standards do not have to be set in a governance structure by accountants. They need the accountants' expertise to determine what the standards should be, but, in terms of the governance of the organization, all the stakeholders must be involved. That is what we are saying.
Senator Fitzpatrick: You said you would like to see some legislative response to this. I think it would be helpful, if you have not already done so, to submit a model that you would recommend as to how this change in the structure should be done. What kind of representation should it have? Who should be the representatives so that there is not only the appearance of an appropriate structure, but that it is one that would be effective and efficient.
Mr. Legault: We would be more than pleased to do that. As I mentioned earlier, we thought we still had some convincing to do. If you are already preparing to look at models for implementation, we would be more than happy to provide our thoughts on that.
The Chairman: As I listen to the senators, it seems that you do have some more convincing to do. Could you explain why lawyers or engineers do not have an oversight board — or do they? I am not saying you are wrong. I am trying to think this question through.
Mr. Legault: People do not find this part of the argument very interesting, but we must make a distinction between accounting standards and auditing standards. Accounting standards ensure that financial reporting is comparable between corporations and even countries. All stakeholders have to be involved.
Auditing standards, on the other hand, are the professional standards. The professional standards used to be set out by the professions everywhere. In the United States, it is now done through the SEC. In Canada it was a decision of the CPAB to have another oversight body for auditors.
All of that has come into effect because of what we have learned over the last 18 months. Accounting has a major impact on the economy so that when accounting fails it is a major issue.
Self-regulation has its pluses, but we have come to a point where we need to distinguish what parts of that should come within the professional organization. We are now saying that accounting standards should be outside and separate. That is the way it is done everywhere else.
We also believe that accountants and auditors have a lot of expertise to offer in the setting of audition standards, but the environment is such that other structures have to be created.
Senator Kelleher: Thank you for appearing before our committee. In several weeks, our committee will be taking a trip to New York and Washington. One of the areas that we will be looking at is the new regime under Sarbanes-Oxley. There has been a lot of discussion as to whether Canadian companies should be exempted in whole or in part. How should we treat Canadian companies that are active in the States?
Can you give us some guidance on what issues we should be pursuing when we speak to these officials? We may even talk to the authors of the act. Whether we will be successful in finding out everything we need to know, I do not know.
Mr. Legault: We will provide you with comments we prepared on the new independent standards which were recommended recently. That will cover many of those issues.
Obviously, today we have come here with the intent of discussing accounting standards structure. Regarding the Sarbanes-Oxley legislation — and they are also aware of this in the United States — there is a concern about how it will impact on small and medium enterprises in Canada. We should not put in place rules that will affect the SME sector to a point where it cannot be the motor of the economy that it has been for quite a number of years.
We must guard against applying principles to everyone just because we think the principles themselves are practical and make a lot of sense. The burden of these new rules could negatively affect some of the small and medium-sized companies. I would be happy to provide you with specific written comments.
Senator Kelleher: First, following the question put to you by Senator Angus earlier in which he suggested you provide us with some particulars, I would point out that members of the committee are concerned that we not overburden small and medium-sized businesses, just as you said. Anything specific that you can give us in that particular regard would be most appreciated.
Second, going back to Sarbanes-Oxley, do you advocate that we adopt the text of that act or that we have a made- in-Canada act?
Mr. Legault: We have not taken a policy position on whether we should adopt it or not so, unfortunately, I am not in a position to answer your question.
We have in fact taken a position on basically each of the provisions, which means that it would be unlikely that you would just apply it as is. Probably some adjustments will be needed.
Senator Kelleher: Do you have any personal thoughts, aside from those of your organization? I am sure you have studies this.
Mr. Legault: Since I am here to represent my organization, I would prefer to leave it at that. As I said, I came here today to talk about accounting standards and how important they are as a public policy issue. With all due respect, this is what I am prepared to talk about today. I do not think it would be doing justice to go into some of those other topics at this time.
Senator Kroft: At the risk of going over ground that my colleagues have already covered, I would like to come back to the principal point you are making about the independence or the appearance of independence of the supervisory board. That is an important point and it is what you came here to talk about today.
I will be very direct in my questions because we have seen you and your organization on other occasions and we know that there are other agenda items. Not to impugn your credibility, but we must be objective in terms of the status of the two accounting organizations. I want to be clear and to help make sure that your credibility is unassailable.
I notice in your efforts to be direct and objective that you modified your language a little bit. Where it talks about a system that is simply too cosy, you chose not to offer that in your verbal report.
Coming back to the CPAB, can you again take me through the exact reasons why you feel it fails in at least the appearance of objectivity? You talked about staffing and space. It would be helpful if you would just take me through the membership and the other elements that you feel may impugn the image of independence.
Mr. Legault: You are talking about the CPAB, the Canadian Public Accountability Board?
Senator Kroft: Yes. On page 3, you refer to the loop in terms of the standards board and the accountants. Then you say, ``I am referring of course to the creation of the Canadian Public Accountability Board or CPAB, which is also flawed in its non-inclusive structure.'' My question is aimed at that comment.
Mr. Legault: The CPAB is a step in the right direction in terms of governance. It has more than just one professional body; it includes representatives from the securities commissions. The Office of the Superintendent of Financial Institutions is involved in the governing council.
Senator Kroft: Are there any outside or lay members?
Mr. Legault: At the council level the board has people from outside the profession. They will also have four accountants, three of which will be CEOs of provincial institutes of chartered accountants and the other has yet to be named.
In Canada, we have three recognized accounting bodies. This organization will look at auditing standards. We believe there has been a lack of inclusiveness in its creation by not including the other accounting bodies.
On the one hand, it is a step in the right direction because it has more people involved in the governance. However, on the other hand, we seem to be repeating the mistakes of the past, that is, accountant standard setting that is not all- inclusive.
Senator Kroft: This comes back to the familiar issue between the institute and the CGA, that is, the recognition of professional bodies. Your automobile analogy makes sense to me. You talked about selecting one automobile company to set the safety standards for all the others. You did not use the analogy of the whole of the automobile industry setting the safety standards.
In the governance of the CPAB, I recognize that only one accounting body is represented. What are the numbers? Could you put on the record the number of people on the governing body of the CPAB? How many are auditing professionals, and who are the others? I am trying to determine where the ultimate control lies over governance issues in that body. How many are there on the governing body? How many are professional accountants, and how many are from other professions?
Mr. Legault: I would have to go by memory, but there is a governing council of four individuals. There are four accountants on the board and, I believe, another seven members.
Senator Kroft: Setting aside for a moment which accounting professions they represent, the professional accountants are a minority on the governance board. The executive committee is made up of four people. Who are those four?
Mr. Legault: There is a person from the Institute of Chartered Accountants, one from OSFI, and David Brown and another person representing the securities commissions.
Senator Kroft: The issue is not one of whether the accounting profession dominates or even controls the CPAB, the issue is that it is one accounting profession, and it does not represent both.
Mr. Legault: It is a different issue from accounting standards altogether. The issue is about auditing standards, which are professional standards. It is also a way of operating. I would have to wait to see what takes place when the organization is functional, but we have been told that the standards will be determined by the institute and then will be given to the CPAB to apply to everyone.
Therefore, even if our members are covered by the CPAB, there will remain the issue that they may be covered by rules designed by someone else. As a professional organization, we find it offensive that we are not part of it. It is a totally different debate from the debate of accounting standards.
Senator Kroft: Your preoccupation is now clear to me.
Senator Tkachuk: The governing body in the United States on accounting standards was separate. In other words, it was not like ours, which was governed by the Institute of Chartered Accountants. In the States there was a separate governing body, a more independent one.
They were aware of the problems with consulting contracts and audits in the United States, were they not?
Mr. Legault: You have to look at two different issues. You have on one side the organization responsible for setting the standards. You are referring to issues that are not really accounting standards issues. They are ethical rules that basically govern the profession.
Senator Tkachuk: The professionals themselves.
Mr. Legault: There was an oversight board that did not seem to work. As you know, the members all resigned. They have started to create another oversight council only for auditing.
Senator Tkachuk: The issue was not accounting standards, the issue was ethical considerations and how the organization governed itself. It had to do with business practices.
Mr. Legault: Some of the issues in Enron were accounting standards issues and some were business practice issues. Others were ethical issues, and others still were probably criminal issues.
Senator Tkachuk: Have we had the same kind of sort of melt down or calamity in Canada that they had in the States with ethical issues and how the profession was acting regarding accounting standards and criminal issues?
I understand what you are saying about how it looks and what it is, but have we had the same problems that they have had in the United States where they have had an independent board?
Mr. Legault: We have had our share of problems, although I do not want to be specific. The question is, do we want to wait until we have to deal with issues that could have the same impact as they had in United States, or do we want to ensure we create the accountability to avoid anything that of magnitude?
Senator Tkachuk: In Canada public corporations have gotten into trouble because of bad business practice, or perhaps criminal wrongdoing. Those issues aside, on the accounting end, you should be able to name some examples. I cannot think of any right now.
Mr. Legault: I cannot think of any either. I believe some had to restate earnings. I would be happy to do some more research and get back to you. Of course, there has been the debate on the expensing of stock options, but that is a standards issue. Companies have started to deal with that voluntarily before the standard setter decided to move on it.
Those are some of the issues that are covered under accounting standards.
Senator Tkachuk: There is an argument to be made that the independent boards have not exactly solved the problem. In other words, where they reside, the issues are worse or just as bad as they are here.
Mr. Legault: You are talking about the United States?
Senator Tkachuk: Yes.
Mr. Legault: I made that point earlier. No system is perfect. We saw what happened in the United States. If there is criminal intent, it is very difficult to have rules that would cover every situation. However, we still believe it is better to have the best practices in place and try to avoid any major issues.
Senator Tkachuk: I do not want the government to fund another organization that will not do a better job than the organization we have now, despite what you consider to be an appearance problem.
Mr. Legault: On the funding issue I must say that much of the funding in most places is done by the users. Currently, our members contribute to the process by buying the handbook. Many of those processes are funded by the users.
The Chairman: It is like deposit insurance. Basically, the banks pay for it.
Senator Fitzpatrick: I wish to follow up on Senator Tkachuk's remarks. It would be helpful to me if I had some statistics to show how many failures there have been in Canada for bad accounting practices or inappropriate accounting practices, versus the United States, U.K, Australia and other jurisdictions. I know that we would be looking at countries of different sizes. Perhaps our structure here is all right, but one of the ways to determine that is to compare ours with the structures of other jurisdictions. I understand what you said about appearance, but I think we should be concerned about effectiveness. Perhaps our structure is effective. I need more information in order to be convinced.
The Chairman: Is it possible to get such statistics? Do they exist?
Mr. Legault: There are two issues here. I am not sure that such statistics exist, and one of the reasons for that relates to the intricacies involved in determining where failures come form. When Enron failed, everyone pointed the finger at the auditor, but it was later realized that a lot of people were involved. What created the failure? Was it the business plan? Was it the accounting? Those could be a part of it. However, I am not sure that those statistics exist and, if they do, I am not sure it would be feasible to get them.
Senator Fitzpatrick: That is my point. If you want to make a case, you should bring us some evidence and do some research in order to give us some guidance.
Mr. Legault: You say that maybe it is just an appearance of conflict of interest. If it is only that, and we are satisfied that we can live with it, I would ask why we are creating the Public Accountability Board. Why are we imposing these new rules on auditors and audit committees to ensure that they are independent? It is the same issue.
Senator Tkachuk: That is a good question.
Mr. Legault: If it applies everywhere, it should apply to all our structures and institutions.
The Chairman: Is the bottom line not that, in order for us to succeed, we must have investor confidence? We have to decide whether this will enhance investor confidence. You could say that in the last six months there have been no fires in Montreal, so why do we have fire trucks. I will admit that may be a silly example.
Senator Fitzpatrick: Pardon my ignorance, but I do not know the answer to this. Are there two auditing accounting professions in the United States, like we have here in six or seven provinces?
Mr. Legault: There are two designations in the United States. There is the CPA and the CMA, the management accountants. Management accountants do not have audit rights in the United States.
Senator Kroft: In all of this we are only talking about publicly listed companies, so when you talk about small and medium-sized businesses are you talking of those that come within the realm of public companies?
Mr. Legault: No, our accounting standards in Canada apply to both public and private companies, and SMEs. This is where we raise the flag. We have to be very careful when we look at those issues. Sometimes we think that the issues and the new rules we want to put in place affect only public companies, and that is not the case. Our accounting standards apply to all companies.
The Chairman: Thank you, Mr. Legault for your time. Perhaps we will have you back.
Senators, our second and last witness is Mr. Dimma from Home Capital Group Inc. I have known Mr. Dimma for about 40 years. We are old friends.
Please proceed with your opening statement.
Mr. William A. Dimma, as an individual: Honourable senators, I am delighted to be here again. Since I believe so strongly in first-class corporate governance, it is good to know that a key Senate committee is equally if not more interested in ways to improve it. With your indulgence, I will speak for 15 minutes, after which I will do my best to respond to any questions and comments.
The first part of my comments will be what might be called stage setting. In part two, I will present to you 11 modest recommendations for change in best practice, though not necessarily changes requiring more legislation or regulation. In the stage setting part, the first part, you may not hear much that is entirely new, but I promise you will hear things from the perspective of the ultimate beneficiary of good governance and good performance and the ultimate victim of bad governance and bad performance, and that is the shareholder.
Almost all of the dozen large and recent corporate fiascos in the U.S. started with problems related to greed. Please do not misunderstand me. I know, and I guess we all know, that greed is a natural and normal part of the human condition. It is an essential motivator. It is part of the engine of economic growth in a free enterprise system. If the word offends, call it something else: ``excessive acquisitiveness.'' Of course it must be checked and kept under control. It is somewhat like a muscle car with a 350 horsepower engine and faulty brakes, or maybe no brakes. Corporate greed without the appropriate checks and balances leads too often to corporate disaster. That has never been so vividly demonstrated as over the past year, and one half in the U.S.A.
Stock ownerships and stock options, as you know, have, for perhaps a couple of decades, been widely viewed as essential to helping make the interests of management and the interests of shareholders mesh and come together. The mix between ownership and options has tilted steadily towards options, especially through the great bull market, which, at least in the U.S., ran from perhaps 1991 to 1992 until the great blow-out which began with the techs in mid- 2000 but sadly spread to much of the broader market by mid 2001 and continuing. Options, without the building in of various protection mechanisms, can have perverse consequences, and I will come to that in a moment.
Before that, though, let me say a few words about these protective mechanisms. Too many of them have been shunned by too many corporations, which rule makers have not pushed for until recently. Let me name about half a dozen.
First, there is the use of performance options. Honourable senators are familiar, I am sure, with the concept in which one or more hurdles — internal, external or perhaps both — must be met before options can be exercised.
By the way, there is a great irony here. In the U.S., as honourable senators may be aware, regular or so-called vanilla options are still not mandatorily expensed. Only recently are a few companies expensing them voluntarily. Performance options, which make so much more sense from a shareholder's perspective, must be expensed, obviously discouraging their use. Fortunately, that dysfunctional deterrent to the broader use of performance options does not exist in Canada. Having said that, performance options in Canada are not yet widespread here anyway. Why? Simply, executives prefer to be awarded with regular options and, until recently, and still to a marked degree, CEOs have usually been able to get what they want in this area.
Another protective mechanism is that options, when exercised, should require the shares that had been acquired to be held for some prescribed period of time. Exercise and no sale for two years would make quite a lot of sense, in my view, and very few companies have done that voluntarily, although a few have.
Another point is controlling the level of grants. Five or six years ago, Michael Eisner, then, and for that matter now, CEO of Disney, was granted $5.5 million worth of Disney options. At the time, that seemed like a lot. Since then, there have been a few lower profile but still larger option grants to U.S. CEOs, each in the billion dollar range.
Another point is that expensing options, which of course is coming very fast to both the U.S. and Canada, will of course help to limit some of the more excessive amounts granted by overly compliant boards faced with celebrity CEOs and external management consultants who know who pay the bills.
Finally, slowing the vesting period, 20 per cent a year from the end of year one to year five, is vastly preferable but not as common as full and immediate vesting at time of grant. I must say that the Canadian record on this score is quite a bit better than that of our southern neighbour.
Even with these sorts of protective mechanisms and some others, problems can arise. Without them, the problems that arose during the last great bull market were of an unprecedented severity. Let me remind you of a few of those problems. The media have been full of some of the higher examples. I refer to these in some of the papers I left with you, so I will be brief.
There was a dangerous preoccupation with short-term expedience, designed to force feed and inflate artificially and temporarily share price levels. This would include many mergers and acquisitions that made no sense whatsoever for the longer run but made a lot of sense for the shareholders at the time of the offer, and especially for executives with options.
Some people were playing with fire in accounting rules and their interpretation. There was rules-based, which is the U.S. approach, versus principle-based accounting practice. Principle-based is the European model, and to a fair degree it is still the model in Canada, although Canada is caught between those two behemoths and has a little of each. There is more room for fraud and deception with rules-based accounting, although outright dishonesty will overwhelm any system.
There was also the unprincipled use of insider information to cash in share sales before the inevitable reaction of share prices collapsing as they lurched back to more sustainable trend lines.
In the U.S., and I will not bore you with spending more than 20 seconds on this, but examples of large American companies that have been guilty of one or more of the things I have been talking about include Adelphia Communications, Arthur Andersen, Enron, Global Crossing, ImClone, Marion International, Tycos, WorldCom and even the esteemed and venerable Xerox.
This point was raised earlier, but in Canada we have been lucky so far through this most recent rash of fraud deception, overreaching and failure, though we had our share earlier. Livent and Bre-Ex come readily to mind. I am not sure of a significant failure in the last 18 months that would come remotely close to the ones I mentioned in the U.S. Certainly, some companies have fallen from grace, and we could start with Nortel, but I do not believe there is anything in that company that would come close to the kinds of things I have been talking about, other than perhaps paying far too much for half a dozen acquisitions which turned out to be worth a fraction of what they paid for them.
If I may say so, the difference, then, between the record of the two economies, at least in the short-run — and God knows we should not be smug because we may be next — but I think our less sullied recent performance relative to the U.S. helps to explain why Canada has largely to date avoided or chosen not to adopt new regulation while the U.S. has adopted fairly draconian rules and regulations. It is far too early to say which approach is superior. Perhaps the U.S. and Canadian environments are sufficiently different in various ways to justify somewhat different approaches in the two countries.
I was in New York last week, and I noted that there is a fair amount of delusion and backpedalling going on already in terms of the actual execution of Sarbanes-Oxley and the NYSE-NASDAQ-SEC rules changes. They are subtle, but there is a little shifting going on which suggests that the full intent of the lawmakers of the legislature may not be fully realized.
Incidentally, I do not know whether you have read and analyzed the recently published 120-page Higgs report recently released in the United Kingdom. If implemented fully, and there will be many hoops to jump through before that happens, the changes will be not only many but, in some cases, quite intrusive. For example, they prescribe a very tough test of director independence. I, along with others, have been promoting personally what I thought was a very tough test. My test involved no financial incentive of any kind to a director or company that employed that director beyond simple director's fees. The Higgs report precludes all relatives, which is probably a good change, but not necessarily in every case. No one can chair two public companies. Therefore, my good friend, John Evans, who until recently was an independent director of Alcan Inc. and Torstar Corporation, could not do that, if the Higgs report applied in this country. As well, no two directors can sit on different boards together, which is an interesting point.
The current Canadian guidelines for independence are both weak and confusing. I think the Saucier committee, which reported in the fall of 2001, blinked and acquiesced when it came to tighter definitions. I consider Guylaine Saucier a friend and colleague. They tried to make what I think are somewhat Byzantine distinctions between related and unrelated, inside and outside, dependent and independent. In my own view, a simple test of independence along the lines of what I suggest might be more useful.
I will turn now from description, or state of the union, so to speak, to prescription. I have one more comment on this eternally unsettled issue of more regulation, that is, mandatory compliance versus the more prevalent Canadian approach of voluntary best practice plus mandatory disclosure. I think it varies enormously with the specific issue within the broad field of governance we are talking about. If I may be slightly mildly humorous for a moment, I am in the Mackenzie King camp, although he was talking about World War II conscription, when he said, more regulation if necessary, but not necessarily more regulation.
We had a meeting of the Fellows of the Institute of Corporate Directors on Tuesday. It was reported in The Globe and Mail by Janet McFarland the next day. We talked about the future of governance, things that should be changed. Since this was reported in The Globe and Mail, I can say this without disclosing anything I should not. Peter Dey, who chaired the well-known Dey committee, has now moved in his thinking all the way to recommended mandatory compliance with the 14 guidelines that his committee put forward in 1995. I think it is fair to say that most of the other Fellows think that might be going a little too far. There was quite a dramatic dichotomy between the two points of view. The subject will have to be debated somewhat further.
I will now speak briefly to several areas where change in practice seems to me to make some sense. Please keep in mind — and I know you will — that change can be legislated or regulated under existing legislation, or brought about by voluntary adoption of recommended practice combined with mandatory disclosure of whatever good, bad or indifferent practice is actually followed.
Please remember that regulation will affect structure and process. However, regulation to a much lesser degree will affect culture and behaviour.
Many of the problems that arose in the U.S. over the last 18 months, and probably going back beyond that, have as much to do with culture and behaviour as anything else.
Of these 11 points, some are already being followed by some companies, but I promise you that not all are being followed by all companies. The first involves separating the roles of chairman and CEO. Even the U.S., finally, slowly, hesitantly is getting aboard this issue. The Wall Street Journal ran what I would call an almost epic article about six months ago in which it said that there might be some merit in separating the roles of chairman and CEO. That is the last bastion of support for CEOs. That is a step forward.
The argument for separation is very strong, at least for widely held public companies. Why is that? I would put it in a four-part syllogism. Everyone should be accountable to someone. You cannot report to yourself. The two roles are designed to be complementary through what has been called creative tension and construction interaction. You really cannot do that effectively if one person is playing both roles. Finally, schizophrenia is a dangerous disease.
What has prevented this change from being universal, especially in the U.S. but to some degree in Canada as well? There are two reasons. One is a not a bad reason and the other is not a very good one. The first reason is some feeling that power, if diluted, will be less effective and/or less efficient. That is a reasonable concern, although I think it is groundless. There is an overwhelming desire on the part of many CEOs — thank God not all — to gather and to cling to as much power as society will tolerate. That is not a reasonable reason.
The second reason is that the CEO of a widely held company must report unequivocally and unambiguously to shareholders through the board as a whole led by an independent chairman. That sounds like motherhood, I know it does, but in the real world it is anything but. Where the chairman and CEO roles are combined, this kind of reporting not only does not happen, it cannot happen. Even if the roles are separated, the CEO often still has the clout, at least in the short term, to sideline the board and to dominate pretty much all aspects of the company, including strategic direction, pivotal decisions like a merger, his own compensation within limits, shareholder rights plans and shareholder relations and communications.
I see merit in the proposition that in companies with a control block that control block has a legitimate right to appoint the chairman. There is such a thing as a tyranny of the minority. I refer to that in one of the papers that you may have had a chance to look at. While a truly independent chairman might better represent the minority shareholders, he might represent less well the control block, which, by definition, represents more shares, at least most of the time. I recognize you can have control with less than 50 per cent.
It goes without saying that minority shareholder rights must be scrupulously respected everywhere and always.
With widely held companies, the chairman should be not only separate from the CEO, but also fully independent. That goes back to the much earlier point about independence. He should not be a previous CEO or other insider. He should not be a provider or previous provider of services to the corporation. He should not be — I guess I can make an exception here rarely — normally a fishing or golfing buddy of the CEO.
The fourth recommendation is that with larger companies the chairman's job is full time or close to it. That is a change. The Royal Bank today comes pretty close to that. Knowledge is power. Unless the chairman is prepared to put a lot of time into the job, he will not be able to offset the reality that knowledge is power, and it takes time to accumulate knowledge.
If honourable senators will permit me, I should like to quote briefly a very revealing remark by Peter Grace, the former CEO of W.R. Grace & Co. on this very issue. He said, as reported in Barron's, the following:
Do you mean to tell me that if I work 100 hours a week for 4.3 weeks a month on average, so that I'm working 430 hours a month, some director is going to come in and in three or four hours and outsmart me? I mean that's crazy. No matter how smart you are, if I work 100 times harder than you on a given subject, you have no way of catching me. No way.
That is the sort of frame of mind that relates to this question of separation of powers.
Number five, the board chairman has to be compensated fairly and competitively. There is no free lunch in strong corporate government. What do I mean by that? Specifically, I think he should be paid as much per hour or per diem as the CEO. The job is every bit as important if, perhaps, less labour intensive.
Number six, the board chairman is clearly not a part of management. He is an overseer of management and the leader of the board, which is in turn the central and pivotal intermediary between management and the shareholders.
Number seven, the chairman and the board work collaboratively and creatively with management in developing strategy. They work together on that, but the chairman and the board delegate the execution of strategy totally to management, subject to that execution remaining true to the strategy and concept and true to the business plan and financial terms.
Number eight, the board has and, when necessary, uses the power to hire and fire the CEO. Too often, this decision is deferred for too long, particularly when the CEO has more power than the chairman and especially if he is both CEO and chairman.
Number nine, the board alone — with the emphasis on ``alone'' — has the power to appoint new directors and, when necessary, to dismiss them. The CEO's advice should normally be sought but he does not and must not manage the process.
Number ten, which is crucial, the board has absolute power over CEO compensation — its amount, its make-up, its components and what hurdles have to be met to earn the variable portion. The board or the board committee is supported, when necessary, by an executive compensation consultant — and this is important — who has no other appointments of any kind from the company or its management. If that consultant is beholden to anyone, it is to the board and not to management.
Number eleven, despite all of the above, the board and management understand that the CEO and his team are managing the business. Nothing I have said has anything to do with managing the business. No board can manage, but all managements must be overseen by an active and committed board that is not only ultimately in charge but also genuinely in charge. That ultimate board control must be real and not merely governance jargon, which is too much concerned with form and not with function.
Honourable senators, that concludes my formal remarks, except to repeat one thing, if I might. In the Canadian setting, voluntary adherence to best practice in some of the areas I have been talking about is at least as good and perhaps better than new legislation or new regulation. That is only my view. A number of governance hawks, perhaps spooked by recent U.S. failure in governance and the subsequent scramble there to enact new legislation, want to go the U.S. route and enact tougher new laws and regulations. I can understand that in some areas. It is especially needed in the area of accounting audit and audit committees, but there are other areas where I do not think that is the right way to go. While none of us as Canadians should be smug, we have not yet demonstrated the depths of perfidy, if that is the proper word, that we have seen in the U.S. in the last 18 months.
Senator Meighen: Mr. Dimma, that was clear, concise and stimulating.
Would you agree with me that whether or not the recommendations you suggest were in place Bre-X would probably still have happened?
Mr. Dimma: That came up with your previous witness. I do not think regulation, new legislation or governance will make a great deal of difference with fraud.
Senator Meighen: There is regulation against fraud. I think it is in the Criminal Code.
Mr. Dimma: By that, I meant the detection of it. To answer your question, yes, I agree with you.
Senator Meighen: In the various protections you listed, you suggested that the level of grants be regulated.
Mr. Dimma: Option grants.
Senator Meighen: Yes, option grants. What would be the possible standard of that? Would you make it dependent on the capitalization of the company or the salary of the CEO? What would you tie it to?
Mr. Dimma: Senator Meighen, I do not recommend regulating level of option grants. I recommend that boards take a tougher and more proactive position on the levels. Although they are way off the scale, some of the grants I referred to are simply obscene, but I do not believe we should try to regulate that.
Senator Meighen: I misunderstood you. It should be a function of the board to say $500 million is obscene and absurd; is that correct?
Mr. Dimma: Exactly, and I think that expensing them will have a beneficial impact on that point.
Senator Meighen: Economic conservatives always say that the market regulates and the market tends to impose its own discipline. I am a bit of a sympathizer with that view. Why did the market not regulate the outlandish salaries that started to become so common, particularly in the U.S.?
Mr. Dimma: I am not sure I have the entire answer, but one component is that options are still a relatively new phenomenon as far as executive compensation goes and I think many people were not quite sure what the outcome would be over the five- or seven-year period of an option grant. Of course, the incredible bull market that we all know about caused some unbelievably generous grants to be made.
Another component is that the U.S., and perhaps Canada to some degree, is having difficulty understanding where CEOs fit into the economic spectrum. Are they to be paid like Michael Jordan?
Senator Meighen: To conclude, I should like your comments about the concept of a lead director as an alternative or as an adjunct to the measures you have put forward. Also, as you mentioned, I do not think any of us believes that Canadians are wildly less greedy than Americans. We are perhaps a little bit so, because we are too modest, but the fact is that our American friends tend, in many instances, to view things as being their way or the highway. When talking about inter-listed companies, it will be very difficult for us to say, ``Just a minute, we have a different way of doing things.'' Even companies that are not inter-listed may be looked upon somewhat unfavourably if they do not stand up and salute all the regulations of Sarbanes-Oxley or whatever.
To what extent can we paddle our own canoe in that regard?
Mr. Dimma: I will take the first and easy question first. I think a lead director is better than nothing, but I consider it a second-best solution. It at least allows for some things to take place. It allows the board to meet usually independent of the management. It probably facilitates director assessment, whether it is peer group assessment or collective board assessment, but I do not think it changes the calculus very much with the big issues. If the CEO/chair is running most of the board meeting, I think it is an imbalance between management and the board that is not good enough. Therefore, it is better than nothing but it not as good as clear separation.
The second issue is a very difficult one. I suspect, as is true in every aspect of our society, that we will perhaps be dragged into something somewhat similar to Sarbanes-Oxley over the next period of time. Certainly with inter-listed companies it is a non-issue. With companies that are not there but still would like to attract U.S. investors, it will become an issue.
I am somewhat of the view that, like it or not, we may move in that direction.
The Chairman: If you are listed on the New York Stock Exchange, you have to follow their rules, unless we get the exemptions we are talking about.
Senator Kroft: On the question of exemptions, there is some talk about trying to seek exemptions from the impact on inter-listed companies, and I have seen it on behalf of European companies, too. Is there anything in that, in your view, or is that a non-starter?
Mr. Dimma: It depends on the extent to which you are inter-listing in order to get U.S. investors. If I think about it, I guess that is about the only reason for inter-listing. If you do get exemptions and then have to provide explanations for why there is a difference, I suspect you are weakening U.S. interest in your stock. Even if you can get the exemption, I am not so sure it will make sense to hold out for that exemption for those companies that really do depend a lot on U.S. shareholders.
Senator Kroft: Generally, Mr. Dimma, I applaud your presentation, if for no other reason than that I agree almost entirely with your points.
From my own experience on boards, on the issue of separation of CEO and having it both ways, there is no question. As you begin to develop that thesis about coming closer — I will not say ``a balance of power'' but it does get closer to a balance of power.
Mr. Dimma: Yes.
Senator Kroft: Have you seen in your own experience examples where that really works? In compensation it probably does work. As you get into board selection, you get into tougher ground. As you get more into strategic issues, there is even tougher ground yet. I am curious as to whether you can give us examples of where this has been effective.
Mr. Dimma: It is an excellent question. As always, the devil is in the details. I did try to say, at least philosophically, that the board cannot and must not try to manage the company. I agree that, when you get into detail, you must define what that means. You have mentioned a number of factors.
I have sat on 50 boards over 40 years. I have only seen one case where a chairman, who happened to be a very dominant personality, tried to move into what I would call the appropriate prerogatives of management. The situation was messy, and eventually one of the two of them was not there. However, I do not think that is the norm. A thoughtful CEO who is willing to recognize that there is a legitimate role for the board and a chairman who does not attempt to be over-reaching can work collaboratively and can have a very harmonious relationship.
I hope that does not sound overly idealistic. I have seen it at work.
Senator Kroft: That is comforting. At the beginning of your remarks, you referred to ``vanilla options.'' Do you mean all the basic and regular options?
Mr. Dimma: Yes.
Senator Kroft: You also referred to performance options. Again, I agree with almost all that you had to say there.
You said that vanilla options are not usually expensed but that the more attractive type are being made less attractive because they must now be expensed?
Mr. Dimma: We are only talking the U.S. now. Yes, that has been case for the past 15 years. It makes no sense. Basically, that is one way to discourage widespread use of performance options. That may suit some people very well.
Senator Kroft: This is something that I admit I should know better as a member of this committee, but are you saying that, for 15 years, performance-related options in the U.S. have been expensed as a matter of law or of practice?
Mr. Dimma: It is certainly a matter of practice and I believe a matter of law — yes, definitely as a matter of law.
Senator Angus: Thank you for attending here, once again, on the same subject, which is obviously important for resolving investor-confidence issues. We have to get this corporate governance thing right. It is more than a year since you were here. We are still talking about the same issues.
In your remarks, you alluded to what an independent director is and how we are wrestling with that. You correctly tied it to financial reward. Basically, to be a truly independent director, you say the only financial interest should be the fee itself. Could you expand on that? There is a view in Canada, where we have a much smaller pool of sophisticated and experienced people who would qualify as independent directors, people who are not service providers nor lawyers nor the like acting for these public companies.
What would be a good standard, in your mind, in terms of compensation to attract competent directors? The Higgs report says what you should not do, and I heard your reference to fishing and golfing buddies. We will get to Nortel in a minute. I should like your comments on reasonable compensation.
Mr. Dimma: That is a great question as well. First, let me start with my bias. At this point in my career, the question is not as important as it might have been 20 years ago. I do not think I have any personal bias, unless it is residual from the past.
I think directors in Canada are quite underpaid. They are underpaid for what they should be doing. Five or ten years ago, someone said they were the best bargain in town. I think they are still the best bargain in town. They may not be vastly underpaid for what they used to do — and it may be a cliché to refer to the old boys club, but that is way back.
As I have said in my book, for better or worse, directors should be paid about the same amount per diem as the CEO. When I wrote that, I heard a fair amount of criticism about directors are not worth that. No one put it quite that bluntly, but there was a sense that such pay was not appropriate. I still hew to the view that a director plays just as important a role as the CEO, if the director is doing what he should be doing, and should be paid roughly the same amount per the amount of time.
I would go so far as to say that today's fees ought to be roughly doubled in Canadian-dollar terms for Canadian directors. How you divide it up is another matter.
Senator Angus: That is interesting and consistent with what I know you have said publicly. Is it your view that all directors of a company should be paid the same? Audit committee members, audit committee chairs, HR committee chairs — all have a very onerous responsibility both legally under Sarbanes-Oxley and in reality, given their leadership roles. That will allegedly create two classes of directors, and I know you are against that. However, in compensation it is becoming quite an issue.
Mr. Dimma: I think directors playing the same role should be paid exactly the same. Sadly, that is not the case. I know of many cases, as I am sure you do, where American directors are attracted up here and are paid in U.S. dollars, which means they get a 52 per cent premium. I am not sure that is right, but yet I am not sure I have a solution on how to attract U.S. directors to Canadian companies.
Senator Angus: Perhaps if we double our fees, that would work.
Mr. Dimma: I think that would do it for most companies.
On the issue of whether a chairman should be paid more than a committee member, I have no trouble with that. If the role is different because you have assumed the extra responsibility, then, yes, you should be paid more. However, you should not be paid more per hour devoted. You will spend a lot more hours as a chairman. You might have a fee at the front end that would be incremental, but for the amount of time it should probably be at the same rate. However, because you will spend a lot more time, you will earn money anyway. You will earn more money and have a higher fee.
Senator Angus: When you refer to a fee — and I want to ensure I have this right — I am reading into your earlier comment that a director's only financial interest should be his or her fee. You would be against options. You would be against share payments for directors; correct?
Mr. Dimma: No. When I say their fee, I mean the compensation package. On the issue of options for directors, I am slowly evolving to the British notion that options for directors are not entirely appropriate. I did not think that a few years ago. I have changed my mind partly because of some of the things that have happened.
To be fair, I cannot think of an example, although there may be some, where directors have been paid ridiculous amounts, or have made ridiculous amounts, through options. In Silicon Valley, there were a few cases before the roof collapsed. There were a couple of boards, and SISCO may have been one of them, where the directors, in one year, each earned $1.5 million through option exercise.
Senator Prud'homme: Was that gross earnings?
Mr. Dimma: Yes, it was, but I do not think that is the issue here. On the issue of options for directors, I think I am on the fence, which sounds namby-pamby, I guess. On the whole, I think it would be better if we paid them properly and stopped the grants. Deferred stock units that put off the taxation payment until retirement make that attractive.
Senator Angus: The model that I detect evolving in some major Canadian companies is a package that would include a retainer for a certain amount of cash, payable quarterly; and an element paid in stock, for example $50,000, with one- quarter of $30,000 payable each quarter and the balance of $20,000 paid in stock on a quarterly basis also.
Mr. Dimma: I think that makes sense. This is all public information. I sat on the board of Sears Canada for 20 years and I was part of the design of the compensation system for directors, although it did, to some degree, follow the U.S. model. One-third cash, one-third stock grant and one-third deferred stock units, DSUs. That is not a bad mix. There ought to be some stock in the equation, but perhaps it ought to be stock grants rather than stock options.
Senator Angus: I was grabbed by the title of your article on best practice: ``Individual Competence, Collective Impotence.'' Of course, you refer not only to Enron but also to Nortel. The gist of it, as I understood, was that two corporations got into trouble — maybe different types of trouble, but grave trouble in both cases. The directors, at least on the face of it, in both companies were a collection of upstanding individuals with good reputations for integrity and competency in general areas in which they were expected to be knowledgeable.
I would like to focus for a moment on the Nortel side of that. I think you also said in your remarks that the only bad thing that you seem to see there, apart from the stock going down, was that, in hindsight, they may have made some improvident acquisitions. In the text, you also acknowledged the fact that a number of the officers and directors cashed in and made big ``killings.'' Nortel people — friends of ours that are in the fishing clubs and the golf clubs around Toronto — are still in office. This must be a bit of a sensitive area. I do not want to embarrass you or anyone, but are we not kidding ourselves?
Mr. Dimma: The Chairman of Nortel is a good friend of mine and many of you will know him. He is an outstanding Canadian by the name of Mr. Red Wilson. The former CEO of that company exercised $135 million in options six months before the stock collapsed. I would like to think he did it because the stock came due and so it was appropriate and there was nothing more to it than that. I am not able to say any more than that about it. Certainly, the perception was not good when your typical shareholder saw the stock drop from $124.50 to about $1.50. It has rebounded a bit to just under $4 per share.
Yes, I think that is a problem.
The Chairman: Could I interject? When Mr. John Roth sold $135 million in stock it was public knowledge.
Mr. Dimma: Yes.
Senator Angus: It was not until six days to two weeks later.
The Chairman: Could not other shareholders have sold their stock if they had wanted to?
Senator Angus: The stock had gone down another $25.
The Chairman: I do not think it had. I am on your side — I agree with you — but he did not sell those stocks in the dark.
Mr. Dimma: Could I say one thing on this point that you are raising, senator? Inevitably, insiders have more information than outsiders have. I am not ascribing anything to Mr. Roth, but that is a fact of life, is it not?
Senator Angus: What I was leading to, really, is that most of the directors of Nortel — all of them, as far as I am concerned — fit into the description of upstanding members of the community, as did the Enron people. Yet, when you say ``individual competence,'' and ``collective impotence,'' why do you say that? That is my question.
Mr. Dimma: I would like to think, senator, that the 11 humble suggestions for change would collectively increase the level of potence.
Senator Angus: I find it unbelievable because no changes have been made yet in the case of Nortel. If we applied the 11, there was certainly a good separation between the CEO and the Chairman — Mr. Wilson and Mr. Roth — and the subsequent person. In respect of all the other items, I have written them down in detail because I am on a panel in Toronto in two weeks time. I find the subject, as you do, fascinating. However, it boggles the mind to know that you have a board of such fine people on the face of it, and yet such a thing can still happen.
Mr. Dimma: In a nutshell, senator, my bottom-line argument is that you have to redress the balance of power between the management and the board. The board has to have a greater measure of power. That is certainly true in the matter of compensation and the ground rules as to when you can exercise your options and how long you need to hold them after you exercise them. There are many things that a good board, if it has the power, can put into practice that may have prevented at least that part of the Nortel problem.
The Chairman: I am becoming confused. It is a confusing subject. First, I think that the public's level of expectation of what a board can do is vastly exaggerated. Let us take a real case in point.
Senator Angus: We are dealing with one, in fact.
The Chairman: Another case in point is the instance of the Toronto-Dominion Bank blowing $2 billion last year. I defy you to ask any one of the directors if he or she had so much as a clue as to what was happening. Perhaps they did know. I was on that board for 28 years. The basic business of the bank, of course, is lending money, and it provides all the other services. How on earth can a Director know what the loans are and how good they are? The head of credit, twice per year, gives directors guidelines such as: We will only lend 5 per cent to the metallurgy business, or 6 per cent to the garment industry. As a director on the board, you really do not know what is happening.
Mr. Dimma: I would be prepared to say, senator, that there are areas of management where the board will not make much difference, and I suspect that that is one of those boards.
The Chairman: Have you ever spoken to a director of Nortel, as I am sure Senator Angus has and as I have, and asked, ``Why did you pay those incredibly wild prices for some of the companies that you bought?'' It is easy to know what happened with hindsight. However, I still wonder why they did that.
Senator Meighen: Perhaps they thought that someone else would pay those prices if they did not.
The Chairman: That is a good answer, Senator Meighen.
Mr. Dimma: If there is an overriding answer to the issue that you are raising, which is that a board cannot stop all of these problems, it is that you need to have the right management in place — a management that balances risk and gain. I am simply stating the obvious here.
The Chairman: It is the board's responsibility to fire or hire the CEO.
Mr. Dimma: That is exactly right.
The Chairman: I am not being critical; it is just that I do not know the answers.
Senator Angus: It is quite an interesting academic discussion. However, it is a fact, as you have pointed out well, that you can have responsible individuals on the board who take their fiduciary duties seriously and yet, these incredible things can still occur. The impotency factor comes into play.
Mr. Dimma: The classic example, as you are probably aware, is Enron where the chair of the audit committee may have been too academic. He was a professor of accounting at one of the big business schools, in Texas, I believe. Despite that, accounting irregularities were a central part of the issue.
The Chairman: We must distinguish, I think, between a fraudulent act and bad judgment. Was Enron stealing or was it just plain bad judgment? B.C. paid I forget how much for Teleglobe, and, and then wrote off about $10 billion. That was not theft; it was bad judgment.
Senator Kroft: Why was the Enron chair, who is the expert, unaware of the fact that there were games going on with the accounting? That was not a judgment call. That should have been within his knowledge, unless the process was flawed.
Mr. Dimma: The only exculpatory comment is that they got into sophisticated derivatives, which even an accounting professor might have trouble with.
Senator Angus: That is true. With all of the structured products that came with the derivatives business, we find senior members of management as high as CEOs in banks and other financial institutions making about a quarter as much as the traders in these sophisticated products. Many of us sit on boards, so we know that they deal with very complicated matter. You might even need a Ph.D. in corporate finance from Beijing to understand it.
The auditors may come in and advise you to write something off or to take a certain hit, and board members may lack the collective competence to understand all of the details so, hearing these things, they take the auditors' advice. This is why I submit the audit committee has a whole new responsibility and a whole new importance in the standards of how to treat these issues.
Mr. Dimma: If I can add a sentence, it seems to me, and it is easy to say after the fact, that in the case of Enron, Andersen bears a fair amount of culpability. Probably because this was one of their larger clients, they were softer and later in coming to hard decisions than was desirable. They are gone, so that is no longer an issue.
The Chairman: Someday, we will have to have a discussion on how you change corporate culture.
Mr. Dimma: Culture is an important part of it, senator.
The Chairman: It has devolved in the last 40 years, as members of this committee have said a hundred times, to looking towards short-term gains. I think Mr. Rousseau of the Caisse de dépôt just gave a speech in which he said that we should stop issuing quarterly statements, or something like that. Years ago, board members did not care about quarterly statements They were just another thing that came out, but you never worried about them, because you had a number of calls and if you hit a certain point, someone would kill your stock. It did not happen. Do you remember that happening?
Senator Angus: No, there was none of that guidance.
Mr. Dimma: As you know, companies are realizing that guidance is a fool's game and they are stopping doing it. That did not help.
The Chairman: Warren Buffett has said that none of his companies will give guidance.
Senator Kroft: One suggestion made earlier on in our hearings, which we have asked other witnesses about and which we note is not on your list, is the idea of audit committees having independent accounting advice. Maybe this is a role for 61-year-old former partners of firms, who are retired and looking for a boutique function. It would not be a huge re-audit but rather the person would look things over and point out things to which they should be particularly attuned. In other words, it would be another level of independence from management and the board.
The Chairman: A note of caution, yes.
Senator Kroft: Have you encountered this suggestion or given it any thought?
Mr. Dimma: One of the boards I chair, Home Capital, by which title Senator Kolber introduced me, has just hired someone. There had to be an 18-month period between when he left Ernst & Young and when he could join us, but he was able to join us on the audit committee. As soon as the 18 months is over, and it is public knowledge, he will become the chairman of the audit committee. I think that is what you are talking about.
Senator Kroft: I was thinking of it in terms of someone who was retained by the audit committee, rather than being a member.
Senator Angus: That is a human resources argument.
Mr. Dimma: That makes sense.
The Chairman: Thank you for being with us. You have been very enlightening. You are a good catalyst.
Mr. Dimma: I have enjoyed being here.
The committee adjourned.